SPV for the EFSF? Leveraging to buy thrash. That spells trouble.

Finally, the 3rd quarter is over. What a quarter it has been. We have seen most major equity markets get hit so badly, leading to many of them trading in bear market territory. Many market watchers were speaking on CNBC last night, on how glad they were in seeing the 3rd quarter come to an end. The question I have is, do you really think that the 4th quarter will be any better?

This week we saw a nice rally in European stocks at the beginning of the week because European leaders promised to do more to solve the sovereign crisis and there were talks on establishing an special purpose vehicle to issue bonds to raise money for purchase of sovereign bonds of the PIIGS countries. There was also a proposal floated around on using the remaining EFSF to recapitalize the banks. Seems like a lot of ideas for what little is left within the EFSF, whether they will work or not, remains to be seen.

Of all the plans, I feel that the SPV idea is the one which the market cheered most on. Taking Tim Geithner's advice to leverage on the EFSF to solve the current debt crisis. At the beginning, European leaders turned down Geithner's idea but now they seem to woken up to the merits of his plan. For those people who know me, will know that I will always rationalise things. Imagine this, if you are left with 1000 dollars in your bank account and you decided to leverage on this money by placing it in a margin account. Lets say you leverage it 10 to 1, and bought into small caps stocks which are running into cashflow problems and may need more money, what do you think will happen? For me, when you are leveraging good money to buy toxic debt, that is always a recipe for trouble.

You really have to give it to the Americans to come out with a plan to use debt to buy bad debt. Haha. Speaking of trying to add oil to fire. Cannot really blame the US for trying to get the Europeans to stabilise everything. The current sovereign crisis in Europe is hurting the US's plan of implicitly devaluing the USD. The USD has rallied against most currencies, this is really not good for the US and its massive debt burden.

There is speculation on the amount to be put into the SPV. Considering the 440 billion Euros in the EFSF is only left with no more than 250 billion. How much do you think they will place into the SPV? From what I see, at least 200 billion has to be used for recapitalization of the banks, how much is left? 40-50 billion? Speculation is that the EFSF has to raise close to 1 trillion to be able to stem this crisis from spiraling all the way to hell. That means that the EFSF will need to leverage 10-20 times to 1. So what kind of credit rating should be assigned to bonds issued by EFSF? AAA? If they are able to rate it as AAA, we will really have to stand up and clap our hands on how the credit rating agencies are able to conjure up such ratings. I have my reservations on the viability of this plan.

There was a client who asked me, what should we look out for, to determine when the market will turnaround. I honestly think that if we end up with a short term myopic plan to stop this crisis, we will face the same problems within the next 12 months. Anything less than a press of the reset button, there is no way we can come out of this crisis. We have gone past the point of no return. Adam Smith's invisible hand is the only way to do it. Let free market forces get rid of the excesses we have built up over the past 20 to 30 years. Interventions are all sugar pills placebos for cancer treatment. Nothing is going to change.

This week is going to be interesting as we start an new quarter. October has never been a good month for the market and throw in the technical charts. I will not be surprised if the US hits a new year low in this month. We shall see won't we? Economic data coming in has been borderline positive but I feel they still do not reflect the effects of the weakness in Europe and the negative wealth effect from the market capitulation, this could tip the economic indicators to negative territory. This coming week's employment numbers should shed some light.

Are there any stocks to look out for in this market? Personally, I have been trying to find any interesting stocks and something to position for the market recovery. Still not time yet. So I am not going to write anything specific at this moment. Thats all I have for today.

Have a great week ahead.

Best,

SVI